Is Bitcoin Useless?

Ordinarily, a tenth anniversary is cause for celebration and reflection. But there are hardly any encomiums forthcoming for bitcoin, which will soon celebrate the tenth anniversary of its introduction to the world. Satoshi Nakamoto, who wrote the paper announcing bitcoin, is supposed to have created the digital currency in response to the 2008 financial crisis. By decentralizing the financial ecosystem, he was attempting to shift the balance of power from a select group of financial institutions to the wider public.

But the currency’s wild ride of scandals and volatile price swings in the ensuing ten years have obfuscated those intentions. Bitcoin’s tenth year has been particularly painful. Its price has crashed since the start of this year and the coin has lost approximately 70% of its value in a prolonged swoon. Cryptocurrency markets, which mostly follow bitcoin’s lead, have also capsized in value, falling by 73% during this time period.

As if that wasn’t bad enough, it has failed to gain mainstream popularity. People are not using bitcoin, either for retail purchases or trading. After peaking last December, transaction volumes on bitcoin’s blockchain have plummeted. Meanwhile, scandals plaguing bitcoin and cryptocurrencies continue apace. (See also: Cryptocurrency Trading Is The Second Most Common Investment Scam In Australia).

Assessments of bitcoin, whether as a store of value or a medium for daily transaction, have mostly been negative. In a withering editorial, the Economist recently declared that bitcoin and other cryptocurrencies are useless. “There is no sensible way to reach any particular valuation,” writes the magazine and points out a number of flaws in the ecosystem. These include the lack of transparency and security on their blockchains and difficulties in purchasing or transacting with cryptocurrencies.

The Economist is not the only publication critical of bitcoin. Other publications have also documented timelines and their assessments of bitcoin’s rise are in a similar vein. Does this mean that bitcoin, for all its stated noble intentions, is useless?

The Case For Bitcoin As Useless Innovation

Bitcoin’s identity crisis is largely to blame for the current downturn in its fortunes. It was originally designed as an international currency and borderless mechanism for daily transactions.

Except it didn’t turn out that way.

Over the years, reports have documented its use in money laundering and illegal activities even as its clunky interface has ensured that consumer adoption remains negligible. The flip side to this story has been the entry of speculative retail investors who drove up its price to unsustainable levels.

Skyrocketing valuations in cryptocurrency markets have changed the dominant narrative surrounding bitcoin. It is no longer considered a medium of daily transaction. Instead, the cryptocurrency is being branded as a store of value, an alternative investment similar to gold. But the cryptocurrency faces two significant problems here as well.

The first one relates to the bubbles in bitcoin’s price.

Till date, there have been three bubbles in bitcoin. They occurred in 2011, 2013, and 2017. Each time the price has followed a parabolic curve with a sharp increase in valuation that was immediately followed by an equally precipitous decline. During each of these bubbles, bitcoin’s value rose by triple digits and attracted significant retail capital. Thin liquidity volumes played a major part in boosting bitcoin’s price in these bubbles.

The second problem has to do bitcoin checking very few of the basic characteristics of a store of value. Morningstar analyst Kristoffer Inton and his team created a framework to check whether cryptocurrencies could displace gold as an instrument of investment. They focused on liquidity, functional purpose, scarcity of supply, future demand certainty, and permanence. Except for scarcity of supply, bitcoin fails on the other attributes. Not surprisingly, the analysts concluded that cryptocurrencies do not and “will not challenge hold as a safe-haven asset class.”

A Brighter Future Ahead?

All may not be lost for bitcoin, however. Despite the slump in prices, bitcoin enthusiasts point to recent developments within its ecosystem as proof that it may yet make a comeback.

Technological advancements hold out hope for cryptocurrency use in retail transactions. The number of Lightning Network nodes within bitcoin’s network has multiplied since the beginning of this year. (Lightning Network is intended to speed up bitcoin’s network by conducting transactions off its main blockchain.) Cross-chain swaps will enable seamless transactions with blockchains for other cryptocurrencies.

The bitcoin ecosystem also continues to grow with a suite of products that expand its range of use cases. In addition to trading with bitcoin, you can use it as collateral for loans or buy jewelry with it. According to some reports, small and mid-size businesses have also begun using bitcoin’s blockchain to make wire transfers because it costs less.

But the biggest change in bitcoin’s fortunes could come from regulation. Even as the rejection of bitcoin ETFs by the SEC has grabbed headlines, there has been a visible softening of regulators stance. Bitcoin and other cryptocurrencies have become a prominent topic of discussion at Fintech conferences and amongst SEC commissioners.

The latter’s commentary on the topic has changed from criticism to clarity regarding the status of some cryptocurrencies. While the SEC has cracked down on cases of fraud and manipulation within cryptocurrencies, commissioners have also encouraged players within its ecosystem to clean up their act.

The result is that some order is beginning to emerge from the chaos of the bitcoin ecosystem. The formation of self-regulatory organizations for cryptocurrency exchanges is a start. The entry of insurance giants, such as Lloyds of London, into the cryptocurrency ecosystem, is another development that will assuage the concerns of investors, who are otherwise wary of investing in cryptocurrencies. A slew of new investment products, from index funds to retirement accounts, is also making its way into the ecosystem.

Institutional investors are also said to be warming up to the idea of investing in bitcoin. Wall Street’s entry could be a significant game-changer for liquidity in the cryptocurrency ecosystem because, unlike retail investors and short-term traders, they invest for the long-term and could play an important role in stabilizing prices.

Investing in cryptocurrencies and other Initial Coin Offerings ("ICOs") is highly risky and speculative, and this article is not a recommendation by Investopedia or the writer to invest in cryptocurrencies or other ICOs. Since each individual's situation is unique, a qualified professional should always be consulted before making any financial decisions. Investopedia makes no representations or warranties as to the accuracy or timeliness of the information contained herein. As of the date this article was written, the author owns 0.21 bitcoin and 1 Litecoin.

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